Natural gas pricing reform: progressing towards greater deregulation

Introduction

In recent years China has increased the pace of its natural gas pricing reform. As evidenced by the Central Government Pricing Catalogue, in future most services and commodities will be priced according to the market. The reform aims to price energy in the same way as commodities – thus facilitating greater access to natural gas resources, reducing controls on pricing and defining the rationales behind natural gas transportation and allocation prices. A market-oriented pricing mechanism is envisaged, which reflects supply and demand and accommodates price adjustments in light of alternative energy supplies. The reform further aims to streamline comprehensively the non-residential natural gas price in certain cases of direct supply to users under a pilot scheme, while also promoting free trade of natural gas for non-residential use, which will hopefully lay the groundwork for a completely market-oriented pricing system.

Non-residential use

The price of natural gas in China is classified as upstream source price or ex-factory price, or city-gate price or distribution price for further distribution beyond the gate. The base price for ex-factory sale of domestic onshore natural gas is controlled by the government. Suppliers and in-takers are allowed to negotiate the price of a specific ex-factory sale within a 10% range of the base price.⁽¹⁾ The National Development and Reform Commission (NDRC) Notice on Adjusting the Price of Non-residential Use of Stocked Natural Gas (Notice 1835, September 2014) explicitly lifts controls over the ex-factory price of shale gas, coal-bed methane and coal-based liquefied gas and the source price of imported liquefied natural gas. Where such commodities enter into long-distance pipelines and are mixed, transported and sold together with onshore liquefied natural gas and imported mixed gas, the source price and ex-factory price of such mixed gas will be dictated by the market and suppliers and in-takers may enter into transportation contracts.

The city-gate price for non-residential use of natural gas will no longer be regulated by a ceiling guideline price, but rather by a baseline city-gate price. Suppliers and buyers may negotiate the city-gate price within a 20% range of the baseline price for each sale. This 20% ceiling will be lifted on November 20 2016. Prices for distribution beyond the city gate will be determined by the provincial pricing authority, in accordance with the local market.

Four primary goals, as set out below, are envisaged in the city-gate pricing reform.

Adjustable pricing in light of alternative energies

The first goal is to enable adjustments to the city-gate price of incremental gas in consideration of the prices of alternative energies. With reference to the pilot pricing scheme conducted in Guangdong Province and Guangxi Autonomous Region,⁽²⁾ natural gas for non-residential use will be classified as either stocked gas or incremental gas. The city-gate price for incremental gas will be set at 85% of that for alternative energies (ie, commercial oil and liquefied petroleum gas). A system for streamlining the city-gate price for stocked gas was intended to be in place by the end of 2015, to serve as the foundation for consolidation of the city-gate price for incremental gas and stocked gas.

Consolidation of incremental and stocked gas prices

The second goal of the reform is to consolidate the city-gate price of incremental and stocked gas.⁽³⁾Since the second half of 2014, prices for alternative energies such as commercial oil and liquefied petroleum gas have fallen dramatically. Under the envisaged dynamic variation mechanism, such price drops will trigger a narrowing of the difference between the city-gate price of incremental and stocked gas. That is, the highest incremental gas price will decrease by Rmb0.44 per cubic metre, while the highest stocked gas price will increase by Rmb0.04 per cubic metre, in order to consolidate the two prices. Following consolidation, there will be no distinction between stocked gas and incremental gas within each province and a single city-gate price will be adopted, which will facilitate negotiation and adjustment of natural gas prices between suppliers and in-takers.

Free pricing pilot scheme for direct supply

The third goal of the reform is to conduct a pilot scheme for the supply of natural gas to certain direct users at a price not controlled by the authorities. For the purposes of the pilot scheme, 'direct users' refers to in-takers that directly purchase natural gas from upstream suppliers for their own production or consumption and do not subsequently distribute the gas to other users. Factors such as the availability of alternative energies, the lifting of price controls over and increased production of liquefied natural gas and unconventional gas, and the increase in gas consumption among large-scale direct users will possibly enable such direct users to wield stronger bargaining power during natural gas pricing negotiations.

Natural gas trading centres

The fourth goal of the reform is to promote the establishment of natural gas trading centres. The Shanghai Oil and Natural Gas Trading Centre commenced operations on July 1 2015, facilitating spot trading of and bidding for piped natural gas and liquefied natural gas. The gas traded at the centre primarily comprises that used for the pilot direct supply scheme, incremental natural gas and liquefied natural gas, coal-based liquefied gas, coal-bed methane and shale gas that are subject to the market-oriented pricing mechanism.

Residential use

In March 2014 the NDRC issued the Guidance Opinion on Establishing and Improving the Progressive Pricing Mechanism of Natural Gas for Residential Consumption (2014/467), which provides for classification of residential natural gas consumption into three volume levels in preparation for the adoption of the progressive pricing mechanism. The lowest consumption level will be based on a monthly average consumption of 85% of residential households in the relevant area. Natural gas consumed within this lowest level will be priced on the 'cost-recovery only' principle and will be maintained for a relatively stable period. The NDRC explicitly required that the progressive pricing mechanism be fully established in 2015 to streamline the price of natural gas for residential consumption, subject to the provision of support for low-income households.

Comment

Pursuant to the existing laws and regulations, the city-gate price of natural gas is regulated by the pricing authority under the State Council, which controls the baseline price. The distribution price of natural gas beyond the city gate is regulated by the provincial pricing authorities. The trans-province long-distance pipeline transportation price is decided by the pricing authority under the State Council, while the transportation price within the provinces will be set by the relevant provincial pricing authority. Source prices of liquefied natural gas and unconventional gas have been deregulated. The city-gate price of natural gas for direct users has also been deregulated and may now be determined through negotiation between suppliers and in-takers. Approximately 40% of natural gas will be priced in accordance with the market after the city-gate price for direct users has been deregulated.⁽⁴⁾ Further, the relevant authorities have specifically requested the acceleration of public natural gas trading at the Shanghai Oil and Natural Gas Trading Centre.

The ultimate goal of the natural gas pricing reform is to completely deregulate the price of natural gas while retaining government control over tariffs for pipeline transmission and distribution.⁽⁵⁾ The reform will continue to evolve in order to achieve this goal in three ways. First, the authorities will draw on the experience of deregulation of natural gas supply to direct users under the pilot scheme and will continue to promote public trading of natural gas at trading centres in order to achieve market-oriented pricing and pave the way for complete deregulation of natural gas pricing for non-residential use. Second, the authorities will accelerate the establishment of progressive, streamlined pricing for residential consumption while ensuring support for low-income households. Third, the pipeline transmission pricing mechanism will be further improved by ensuring pipeline transmission prices based on a solid rationale and strengthening supervision of transmission and distribution pricing. In tandem, it is hoped that these measures will further the vigorous growth of China's natural gas industry.

For further information on this topic please contact Libin Zhang or Guanggui Yao at Broad & Bright by telephone (+86 10 8513 1818) or email ([email protected] or [email protected]). The Broad & Bright website can be accessed at www.broadbright.com.

Endnotes

(1) NDRC Notice on Increasing the Ex-factory Price of Domestic Onshore Natural Gas (June 2010).

(2) NDRC Notice on Initiating Pilot Reform of Natural Gas Price Formation Mechanisms in Guangdong Province and Guangxi Autonomous Region (December 2011).

(3) NDRC Notice on Rationalising the Prices of Natural Gas for Non-residential Use (February 2015).

(4) See "Three Key Questions Relating to the Natural Gas Price Reform", available at www.gov.cn/xinwen/2015-02/28/content_2823328.htm.

(5) See "Answers of the NDRC Replying as Requested by Reporters on Rationalising the Prices of Natural Gas for Non-residential Use", available at www.ndrc.gov.cn/zcfb/jd/201502/t20150228_665789.html.

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.